Drama in US Government Bonds: An investment opportunity not seen in 20 years?

Is there an investment opportunity not seen in 20 years? US government bonds are perceived as one of the safest assets in the world, but a significant drama is unfolding there these days.

US government bond yields have surged wildly, and the yield on the 30-year US government bond has already reached 5.25%, a figure not seen since 2007, just before the subprime crisis that led to a collapse in the stock market.

In bonds, when the yield on a bond rises, it means that the price of the bond falls; the correlation is inverse. In other words, 30-year US government bonds have experienced a very significant decline recently.

Investors are starting to worry about the government's repayment ability

Before we talk about investment theses, it is important to understand why this drama is happening. Several reasons are causing this unusual rise in yields. The first reason is the huge US deficit and the significant amount of debt that the government is constantly issuing. Investors see the deficit, look at the large debt issuances, and start to worry about the government's repayment ability.

Another reason is fears of a return to rising inflation in the United States in light of the war in Gaza. Energy prices, which are very sensitive to developments in the region, could jump and cause another cycle of interest rate hikes.

One thing must be remembered: whenever there is an extreme event, there is a narrative around it; after all, it is a market, and if that narrative did not exist, we would not see this extreme event developing.

US government bond yields at such a level are something the market will find difficult to deal with, as will the government itself. After all, senior government officials have already stated in the past that the rise in yields caused them to make a U-turn in tariff policy, for example. The meaning of such a high yield on US government bonds is devastating for the government, which is required to pay a huge fortune in interest when the yield is at these levels.

The stock market will find it difficult to continue rising when one can get 5.25% in bonds; after all, the stock market, in light of its risk, must provide what is called a positive "risk premium," meaning that investors should receive excess return for the risk they take when investing in stocks.

The P/E ratio on the S&P 500 is around 26. That is, an implied yield of less than 4% (before considering growth in company profits). Something here has to "break" — either the stock market will fall sharply and then the ratio will drop, or the yield on US government bonds, the "alternative" to the stock market, will fall.

So how do you invest?

There is an ETF that concentrates US government bonds with maturities of 20 years and up, called TLT. It is a very well-known fund (managing $45 billion) and is traded on the US stock exchange. The fund distributes as a dividend the current yield received from the bonds it holds, but it is likely that what will determine the investors' return is not the dividend but the price of the bond, which is very volatile, and this is important to understand because of the duration (average life) of long-term bonds.

The higher the duration, the more volatile the bond is in relation to changes in yield. And this is exactly the reason why this fund crashed by 45% (before dividends, which slightly reduced the damage) in the last 5 years. Buying it 5 years ago, when the yield was zero, was a decision that made no sense, but today, in light of the current levels and certainly in relation to the pricing of the stock market, it is a very interesting asset for an investment portfolio.

This does not constitute investment advice to perform any actions. The author and/or his clients may hold the mentioned securities.